Reports on Wednesday showed that the US Securities and Exchange Commission (SEC) is turning its attention more closely to private equity firms. The focus at the moment is going to be on how private equity firms delineate the calculations of average net returns in previous funds. The move means that the SEC is now also focusing on the performance of private equity firms and not just the fees firms charge.
CNBC reported that the SEC is focusing on the average net returns, or the net internal rate of return (IRR) that it’s also known as, to understand how to enhance regulation of the industry. The move is supported by the fact that the nearly 3,300 private equity firms with headquarters in the US don’t use a standard practice for calculating the IRRs.
The SEC sees the non-standardisation of the fees particularly problematic, as different investors can end up paying different fees for the same fund. The problem according to the CNBC report, also published by the Daily Mail Online, is that “the private equity firm and its managers, called general partners, also typically invest some of their own money into the funds, but don’t pay any fees.”
Furthermore, incorporating the general partner’s money for the IRRs can end up inflating the fund’s average net performance figures. The SEC’s investigation is focused on understanding whether fund managers are disclosing their actions properly.
According to a Reuters review, the top US private equity firms have very different approaches to the matter. For example, firms such as Blackstone Group and Bain Capital don’t mention the general partners’ money in average net IRR calculations, whereas Apollo Global Management does.
But private equity firms do provide the investors the information whether the manager’s money is included in the calculations or not, even though this isn’t typically public information.
David Fann, from the private equity advisory firm TorreyCove Capital Partners, told CNBC that, “Over the past five years, some general partners have started to invest more of their personal capital into their vehicles on a non-fee basis and that obviously can create some IRR distortion”.
No comment was available from an SEC official on this refined focus to performance figures.
The move comes after a period of pressure on private equity companies. The 2010 Dodd-Frank Act has changed private equity law in the US and provided more oversight over the industry. The Wall Street Journal just recently reported on the investigation to private equity consultant fees in US firms. In addition, the focus on the PE consultants also led to the first settlement, when private equity adviser and chief executive of Clean Energy Capital agreed to pay roughly $2.2 million.
So how will the current investigation on performance figures change the private equity sector in the US? According to experts, most companies will start paying closer attention to regulatory compliance measures and most likely increase the amount of information firms share with investors. The pressure has already been mildly successful in forcing firms to simplify the fees and improvement of the expenses structure will likely follow.
Tags: buyout, funds, private equity, Private Equity Law, USA